Leveraged Loans: Where Have All the Buyers Gone?

We’re going to be a bit brief this evening. The Financial Times has a useful item in its Lex column which explains why leveraged loans, despite their seemingly rich pricing, are going begging:

It has been a terrible period for leveraged loan prices – worse than for high-yield bonds despite the unsecured nature of the latter. Some of the reasons may be “technical”, but somehow, that tag no longer has the comforting ring of a short-term blip….

Among these factors is a steeper yield curve, which has rendered floating debt such as leveraged loans, priced off short term Libor interest rates, less competitive in yield terms. Then there are the pressures faced by many of the traditional “go-to” investors for this paper: hedge funds and leveraged buyers. Some of the popular trading programmes that have supported the secondary market are facing margin calls. And credit vehicles, such as so-called CLOs, risk hitting triggers that require asset sales because their underlying collateral is falling in value.

Then of course, there is the economy and the outsized credit risk the banks run if they have to hold onto the leveraged loans they have committed to, as opposed to flogging them to others. Still, as Standard & Poor’s LCD research points out, there is quite a lot of default risk already priced into US current prices which are heading towards 85 cents on the dollar. S&P LCD estimate that default rates would have to rise to roughly 10 per cent to wipe out the excess risk premium priced into current US loans. That is a lot given the 2000 high of 8.2 per cent. But with corporate profits looking toppier than then, and gearing higher, loans may not recover soon. Banks hoping for a respite from their nightmare could face more writedowns yet.

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